SHLDQ - Sears Holdings Corp

[ni-co]

I think what they mean is that pension contributions that suck up the FCF aren't permanent sucks the way that interest and/or cap ex might be -- at some point you stop having to pay for pension contributions so your free cash flow improves considerably.

 

Exactly.

 

Note that the company’s legacy pension obligation is essentially a form of debt and has influenced revolver usage. The $1.1 billion of contributions made in the last 10 quarters have been funded by revolver borrowings. On a pro forma basis, the revolver balance would be $339 million absent these contributions. We have used one form of debt, being the revolver, to fund another form of debt, the pension. Since 2012, about $1.1 billion of the second quarter revolver balance of $1.4 billion was driven by pension contributions which should be distinguished from funding operating expenses.

 

http://searsholdings.com/invest/docs/2014_Q2_Call_transcript.pdf

 

I'm not sure how that has anything to do with free cash flow, which is how the value attributable to the equity holders of the company is determined. The shareholders equity line of the balance sheet will show the value destruction clear as day. Using the revolver to fund the pension doesn't help equity holders very much, except that the interest rate may be lower than other forms of financing. The pension obligation goes down, but short term debt goes up by an equal amount. You still need positive free cash flow to pay down the debt. That is how value flows down to the equity.

 

I'm not talking about FCF – cash burn is not FCF. It's true that pension contributions impair your free cash flow. After all you use the cash for contributions and can't dividend it out. However, my point is that I don't consider this cash "burned" at all. You get the cash value 1:1 in form of a reduction in liabilities. And you actually will see this in the balance sheet.

 

This is my thinking:

 

[EDIT: I think I made two bad errors in my calculation:

1. I double counted for the pension contribution by taking SHLD's adjusted EBITDA – they already subtract pension costs.

2. I should have taken pension costs instead of pension contributions. Only pension costs are costs in the sense of the earnings statement (and they are lower than actual contributions because the expected returns on the pension plan's investments are deducted).

I corrected the following calculations to not confuse anybody who's reading this later:]

 

FY2013

Adjusted EBITDA: -337

Interest expense: -254

Capex: -329

Pension contributions: +426

---------------------------------

Cash burned: $494m

Cash burned: $920m

 

 

Q1 2014

Adjusted EBITDA: -211

Interest expense: -71

Capex: -72

Pension contributions: + 102

---------------------------------

Cash burned: $252m

Cash burned: $354m

 

 

Q2 2014

Adjusted EBITDA: - 313

Interest expense: - 72

Capex: - 54

Pension contributions: + 205

---------------------------------

Cash burned: $234m

Cash burned: $439m

 

==============================

Total cash burned for the last 6 quarters: $980m $1,713m

average cash burned per quarter: $163m $286m

 

(This is all pre-tax).

[ni-co]

To be clear: I don't appreciate that he is burning this cash, but since I assume several billions of hidden assets I see no reason to panic.

[adesigar]

 

The reason for him to move with glacial speed is to preserve cash/assets and keep cash burn low – not the opposite. How much hard cash has really been burned within the last few quarters? Now take a look how much cash JCP has been burning, for example. Is this really the better strategy? That's what I try to focus on, because that's what really impairs my MOS. I don't mind if he "keeps burning cash" as long as it's a reasonable amount compared to the asset values that I believe are still there.

 

 

Keep cash burn low? Free cash flow over the last 6 quarters has been negative $2 billion. That's $19 per share on a $33 per share stock. Now, it's true that 75% of that has gone towards capital expenditures, interest on the debt, and pension contributions (and not operational losses), but cash is cash from an equity holder's perspective.

 

No, it is not.

 

Dont you know?

 

Lampert is dumb and is burning cash in hopes of saving Sears/ creating SYW and becoming famous.

Paying down the Artificialy inflated pension is a perpetual expense.

Long term leases are a liability.

Real estate will be sold 10 years from now at the same price as today so liquidation value needs to be adjusted down to get its current value.

Etc etc etc.

 

Im really hoping the bears push SHLD down to the 20s so I can average down.

 

 

[Luke 532]

If you have 8 minutes to kill:

Senior Leadership Program at Sears Holdings

[TwoCitiesCapital]

 

The reason for him to move with glacial speed is to preserve cash/assets and keep cash burn low – not the opposite. How much hard cash has really been burned within the last few quarters? Now take a look how much cash JCP has been burning, for example. Is this really the better strategy? That's what I try to focus on, because that's what really impairs my MOS. I don't mind if he "keeps burning cash" as long as it's a reasonable amount compared to the asset values that I believe are still there.

 

 

Keep cash burn low? Free cash flow over the last 6 quarters has been negative $2 billion. That's $19 per share on a $33 per share stock. Now, it's true that 75% of that has gone towards capital expenditures, interest on the debt, and pension contributions (and not operational losses), but cash is cash from an equity holder's perspective.

 

No, it is not.

 

Agree.  It is not. 

 

Selling assets to pay down debt (approximately) doesn't change the value of an investment.

 

I agree with you guys in theory, but in practice, theory and practice are different. It’s all the same from an Equity or Book value $ perspective, but not in how financial markets actually work by applying multiples and valuing off of earnings streams.  We all agree that ongoing concerns are measured by the value of cash flows. The only time you value a company by its book value is when the cash flows it earns are directly tied to the value of that book (not always the case) or a company that might go into liquidation. Might I provide an example?

 

 

 

Co. A

 

Asset = $100

 

Cash flow = $10

 

Liability =$50

 

ROE = 20%

 

 

 

Say Co. A sells half of its liability to pay down liability. Now, it has assets and equity of $50 and is only returning $5. Placing the same P/E multiple (or P/B) drops the value by 50%. DCF would fall by a similar amount. Only the book value remains the same; however, the multiple of book value it trades at will also likely come down because the ROE has been cut in half. All in all, this is a losing proposition for the co to sell the asset to pay off debt.

 

 

 

Co. B

 

Asset = $100

 

Cash Flow = -$10

 

Liability = $50

 

ROE = -20%

 

 

 

Reproducing the same experiment could actually improve the co’s performance by reducing losses to $5 per share by reducing money losing operations.  You may still encounter the same issues with scale so the end result may not be as good as -5. It could actually end up being worse than -10, but that’s dependent on a bunch of factors. I’m sure it’s the hope of members on the board that this is what Lampert would be doing. Closing down money losing stores to produce cash to reduce liabilities and ultimately get to a “right sized” company that is much smaller and producing positive returns.

 

Selling assets to pay debt ONLY ever makes sense if the return in the asset is lower than the cost of servicing the debt. Otherwise, you're hurting cash flow streams and market multiples and end up with a lower value.

 

That being said, I think in general Eddie is operating co B and that things like pension expense are temporary so this strategy could make sense.

[Luke 532]

Retail Cap Rates Hold Steady as Property Fundamentals Improve

http://nreionline.com/retail/retail-cap-rates-hold-steady-property-fundamentals-improve?NL=RET-01&Issue=RET-01_20140821_RET-01_344&sfvc4enews=42&cl=article_1_b&YM_RID=CPG09000002830881&YM_MID=283

[zenith]

anybody here like the debt, specifically the

SEARS HOLDINGS CORPORATION

Coupon 6.625% Mature 10/15/2018

 

They are YTM OF 9.52%.

I know they were a better buy in December 2011, but still a great yield.

[Eye4Valu]

Would like to solicit comment on the following question. I think Pabrai's point regarding SHLD's 250k employees standing in the way of SHLD's NAV is a good one. I know that SHLD has been reducing its pension liability, and assume this will continue. If SHLD gets to the point of having its pension fully funded, does Pabrai's point become moot? 

[peter1234]

Would like to solicit comment on the following question. I think Pabrai's point regarding SHLD's 250k employees standing in the way of SHLD's NAV is a good one. I know that SHLD has been reducing its pension liability, and assume this will continue. If SHLD gets to the point of having its pension fully funded, does Pabrai's point become moot?

 

I do not think so.

[Guest wellmont]

Would like to solicit comment on the following question. I think Pabrai's point regarding SHLD's 250k employees standing in the way of SHLD's NAV is a good one. I know that SHLD has been reducing its pension liability, and assume this will continue. If SHLD gets to the point of having its pension fully funded, does Pabrai's point become moot?

the pension is not the issue although that continues to require capital. i believe his point is that in order to realize value from the real estate assets you will need to fire a lot of people. thousands and thousands. that's hard to do. and eddie has only taken baby steps toward a goal of liquidation and exiting brick and mortar retail. you aren't going to realize value here if eddie continues to employ 250k associates that work in money losing sears and kmart stores.

[merkhet]

Would like to solicit comment on the following question. I think Pabrai's point regarding SHLD's 250k employees standing in the way of SHLD's NAV is a good one. I know that SHLD has been reducing its pension liability, and assume this will continue. If SHLD gets to the point of having its pension fully funded, does Pabrai's point become moot?

the pension is not the issue although that continues to require capital. i believe his point is that in order to realize value from the real estate assets you will need to fire a lot of people. thousands and thousands. that's hard to do. and eddie has only taken baby steps toward a goal of liquidation and exiting brick and mortar retail. you aren't going to realize value here if eddie continues to employ 250k associates that work in money losing sears and kmart stores.

 

Yea, Pabrai's point was not about the pension but about current employees. In addition to wellmont's point about the psychological difficulty of firing people, there are also various severance costs involved with it.

[BTShine]

I'd challenge that thinking.  Eddie is shutting down 130 stores this year.  Let's assume 100 employees per store (it's probably a bit less, maybe 70 or 80 per store,  but is an easy number to use).  130 stores and 100 employees per equals 13,000 employees fired this year.

 

I really don't think Eddie would have a problem firing 50,000 or 100,000 employees in a year or 18 month period if that's what it took to preserve capital for shareholders.   

 

Severance costs are real.  And, I'd guess they're manageable. 

 

 

[Mephistopheles]

I doubt it's nearly that many employees per store.

 

This is such a silly reason for Eddie not to accelerate store closings. In the long run it's good for the economy to use the store space and the workers for more efficient purposes.

[20ppy]

 

Dont you know?

 

Lampert is dumb and is burning cash in hopes of saving Sears/ creating SYW and becoming famous.

Paying down the Artificialy inflated pension is a perpetual expense.

Long term leases are a liability.

Real estate will be sold 10 years from now at the same price as today so liquidation value needs to be adjusted down to get its current value.

Etc etc etc.

 

Im really hoping the bears push SHLD down to the 20s so I can average down.

 

+1

 

I will of course load up more if it does happen.

 

Somehow this holds true: for any given opportunity and a group of investors, when both sides have more than a dozen  opposing points and when things look really terrible or beautiful on the surface, only a small percentage of the group can see thru and get the right insights and be right when in due time things settle.

 

 

[Luke 532]

Haha!  Kmart "Shop Like a Boss" commercial

http://www.marketmenot.com/kmart-shop-like-a-boss-commercial/

[Parsad]

Note that the company’s legacy pension obligation is essentially a form of debt and has influenced revolver usage. The $1.1 billion of contributions made in the last 10 quarters have been funded by revolver borrowings. On a pro forma basis, the revolver balance would be $339 million absent these contributions. We have used one form of debt, being the revolver, to fund another form of debt, the pension. Since 2012, about $1.1 billion of the second quarter revolver balance of $1.4 billion was driven by pension contributions which should be distinguished from funding operating expenses.

 

http://searsholdings.com/invest/docs/2014_Q2_Call_transcript.pdf

 

Can Eddie take money out of the pension plan to pay down the revolver?  Cheers!

[adesigar]

Note that the company’s legacy pension obligation is essentially a form of debt and has influenced revolver usage. The $1.1 billion of contributions made in the last 10 quarters have been funded by revolver borrowings. On a pro forma basis, the revolver balance would be $339 million absent these contributions. We have used one form of debt, being the revolver, to fund another form of debt, the pension. Since 2012, about $1.1 billion of the second quarter revolver balance of $1.4 billion was driven by pension contributions which should be distinguished from funding operating expenses.

 

http://searsholdings.com/invest/docs/2014_Q2_Call_transcript.pdf

 

Can Eddie take money out of the pension plan to pay down the revolver?  Cheers!

 

Yes if interest rates go back up the pension could become overfunded in which case he can.  He can sell the pension plan to an insurance company.

[alertmeipp]

Have you guys browse through Sears' job openings?

ESL is no where near going for liquidation mode if those are real

 

[alertmeipp]

Note that the company’s legacy pension obligation is essentially a form of debt and has influenced revolver usage. The $1.1 billion of contributions made in the last 10 quarters have been funded by revolver borrowings. On a pro forma basis, the revolver balance would be $339 million absent these contributions. We have used one form of debt, being the revolver, to fund another form of debt, the pension. Since 2012, about $1.1 billion of the second quarter revolver balance of $1.4 billion was driven by pension contributions which should be distinguished from funding operating expenses.

 

http://searsholdings.com/invest/docs/2014_Q2_Call_transcript.pdf

 

Can Eddie take money out of the pension plan to pay down the revolver?  Cheers!

 

 

Who knows, maybe they have a surplus in next few years.

 

[Parsad]

Note that the company’s legacy pension obligation is essentially a form of debt and has influenced revolver usage. The $1.1 billion of contributions made in the last 10 quarters have been funded by revolver borrowings. On a pro forma basis, the revolver balance would be $339 million absent these contributions. We have used one form of debt, being the revolver, to fund another form of debt, the pension. Since 2012, about $1.1 billion of the second quarter revolver balance of $1.4 billion was driven by pension contributions which should be distinguished from funding operating expenses.

 

http://searsholdings.com/invest/docs/2014_Q2_Call_transcript.pdf

 

Can Eddie take money out of the pension plan to pay down the revolver?  Cheers!

 

Yes if interest rates go back up the pension could become overfunded in which case he can.  He can sell the pension plan to an insurance company.

 

But if interest rates stay the same for 3 months, six months, a year, two years or five years, then he can't, correct?  And if the pension plan remains underfunded, how much would it be worth to an insurance company?

 

I'm just pointing out what a crock of shit the management was trying to feed investors on that conference call.  Cash is cash...debt is debt...and pensions are not simply another form of debt. 

 

If you borrow from your personal line of credit and put it into your Roth/RRSP, you can withdraw it from your Roth/RRSP, regardless of interest rates and pay down the debt.  This is not the same thing with a company-funded pension plan.  Cheers!

 

 

[TeddyLampert]

Someone asked me to share some additional thoughts on the Annual Meeting, so I thought I'd also share my reply with the rest of the group for those who might be interested.

 

 

I remember you attended SHLD's most recent annual meeting.  I was wondering if you'd humor me for a moment.  I just happened upon the following article: http://www.chicagobusiness.com/article/20140506/NEWS07/140509868/at-sears-closing-stores-is-going-to-be-part-of-our-future

 

Below are some quotes/pieces of info, some of which I hadn't heard Lampert mention before.  You were at the annual meeting, do you recall some or all of this being discussed?

 

-He outlined a vision of Sears' stores five years from now that will be physically smaller and sell both Sears merchandise and goods from third-party retailers, much the way the company's online Marketplace currently sells 120 million products, the vast majority of which are not Sears' own merchandise.

 

-"We want to be a partnership company," he said. "Sometimes we're going to be the big dog and sometimes we're going to be a (smaller) piece of a solution."

 

-It's smarter to buy $50 million of apparel 10 times throughout the year than to make a large $500 million bet a year in advance, he said. "We're going to buy more frequently and in smaller quantities."

 

-He also noted that the retailer must currently cater to a wide range of demographics, from older and middle-aged shoppers to teens. "Do we need to be more effective with all of these constituents, or do we need to be much more focused? Those are the things that are being evaluated."

 

 

 

Thanks for the note! I had read that article after the AM. I was curious to read how the local business media (Chicago) covers one of its own. Everything in that article is accurate insofar as it accurately references a comment Eddie made at the AM.

 

Some of the info in the quotes that you raise are new pieces of information for me at that time, such as Sears going into fast fashion in a manner similar to Forever 21. On balance, none of the "new" news took my breath away in the sense that it enhanced my understanding of the company's intrinsic value.

 

Some parts that I thought were most intriguing were the 3 case studies he cited in terms of companies that went through transformations (Kodak, Apple, Gen Dynamics). Of the three, I thought Gen Dynamics was the most relevant. The key difference between Gen Dynamics back then and SHLD now is that I don't think Gen Dynamics was going through as significant a cash burn. The other big difference is that Gen Dynamics was effectively a liquidation of non core businesses, whereas Eddie has a different objective, subtle as it may sound: slowly liquidate certain assets to fund a retail turnaround. With Gen Dynamics, there was no "retail turnaround" (or other cash draining project) to fund, so that unlocked capital could be released to shareholders!

 

The article also reminded me of another concerning point that I had about the transformation plan: he readily acknowledged that SYW is about trying to alter people's behavior and habits. I don't have Munger's wisdom, but if you ask me, I think that's a very tough proposition. My takeaway from the meeting is that it's clear he's very committed to the transformation program, and hence, embarking on a difficult task that elevates the business execution risk.

 

At the beginning of this year, I thought Eddie was set on liquidating Sears Holdings. After I learned how serious he is about SYW and the retail turnaround, I decided it was better to let this situation play out on its own, ascertain the business results (i.e. look at this from the perspective of a business owner and not as a stock trader), and maybe invest later if the fundamentals improve.

 

[ni-co]

Note that the company’s legacy pension obligation is essentially a form of debt and has influenced revolver usage. The $1.1 billion of contributions made in the last 10 quarters have been funded by revolver borrowings. On a pro forma basis, the revolver balance would be $339 million absent these contributions. We have used one form of debt, being the revolver, to fund another form of debt, the pension. Since 2012, about $1.1 billion of the second quarter revolver balance of $1.4 billion was driven by pension contributions which should be distinguished from funding operating expenses.

 

http://searsholdings.com/invest/docs/2014_Q2_Call_transcript.pdf

 

Can Eddie take money out of the pension plan to pay down the revolver?  Cheers!

 

Yes if interest rates go back up the pension could become overfunded in which case he can.  He can sell the pension plan to an insurance company.

 

But if interest rates stay the same for 3 months, six months, a year, two years or five years, then he can't, correct?  And if the pension plan remains underfunded, how much would it be worth to an insurance company?

 

I'm just pointing out what a crock of shit the management was trying to feed investors on that conference call.  Cash is cash...debt is debt...and pensions are not simply another form of debt. 

 

If you borrow from your personal line of credit and put it into your Roth/RRSP, you can withdraw it from your Roth/RRSP, regardless of interest rates and pay down the debt.  This is not the same thing with a company-funded pension plan.  Cheers!

 

This is really fuzzy thinking. You confuse losing liquidity with burning money.

 

1. If he took the money from the revolver and paid back bondholders, how would he get the money back from them to pay down the revolver?

2. Would you consider this money "burned" because he can't get it back?

[TeddyLampert]

Would like to solicit comment on the following question. I think Pabrai's point regarding SHLD's 250k employees standing in the way of SHLD's NAV is a good one. I know that SHLD has been reducing its pension liability, and assume this will continue. If SHLD gets to the point of having its pension fully funded, does Pabrai's point become moot?

 

I posted Pabrai's comments about this a few weeks ago. As I was looking over my annual meeting notes, I have this written down in my journal verbatim. This is a paraphrase of what Eddie said in answer to someone's question:

 

"Not easy to cut jobs and close stores because of [sear's] history. Berkshire's relationship w/3G. You have to cut costs out to be competitive but there is a human toll."

 

Since they didn't allow recording devices at the AGM, my notes are just a paraphrase jotted quickly in real time. If I recall, he was saying they will continue to close down under performing stores as they have been doing, but it's not easy to do it on a mass scale because of job cuts. He referenced Buffett because he was saying that in WEB's recent acquisition of Heinz, the investment will work out because it can cut costs, but 3G will carry out the dirty work, not WEB. Eddie was bringing up this example as if to say: "it's easy for Buffett because he has a hatchet man, but it's not so easy for Sears as I'd have to be the bad guy". Recall the Fortune interview of Eddie back in 2006 where he says he wants to be remembered as a great business man, not as just an investor... All of this adds up to the point that Pabrai was making, which for me negated the quick unlocking of real estate NAV thesis. 

 

Later in my notes, I do record Eddie as saying: "We cannot afford to wait any longer. to close stores [sic]." I cannot recall the details behind him saying this or the question, but it does suggest he has a sense of urgency to close more stores. 

[merkhet]

Would like to solicit comment on the following question. I think Pabrai's point regarding SHLD's 250k employees standing in the way of SHLD's NAV is a good one. I know that SHLD has been reducing its pension liability, and assume this will continue. If SHLD gets to the point of having its pension fully funded, does Pabrai's point become moot?

 

I posted Pabrai's comments about this a few weeks ago. As I was looking over my annual meeting notes, I have this written down in my journal verbatim. This is a paraphrase of what Eddie said in answer to someone's question:

 

"Not easy to cut jobs and close stores because of [sear's] history. Berkshire's relationship w/3G. You have to cut costs out to be competitive but there is a human toll."

 

Since they didn't allow recording devices at the AGM, my notes are just a paraphrase jotted quickly in real time. If I recall, he was saying they will continue to close down under performing stores as they have been doing, but it's not easy to do it on a mass scale because of job cuts. He referenced Buffett because he was saying that in WEB's recent acquisition of Heinz, the investment will work out because it can cut costs, but 3G will carry out the dirty work, not WEB. Eddie was bringing up this example as if to say: "it's easy for Buffett because he has a hatchet man, but it's not so easy for Sears as I'd have to be the bad guy". Recall the Fortune interview of Eddie back in 2006 where he says he wants to be remembered as a great business man, not as just an investor... All of this adds up to the point that Pabrai was making, which for me negated the quick unlocking of real estate NAV thesis. 

 

Later in my notes, I do record Eddie as saying: "We cannot afford to wait any longer. to close stores [sic]." I cannot recall the details behind him saying this or the question, but it does suggest he has a sense of urgency to close more stores.

 

I suspect that you're right. I think ESL will reconcile the two statements by closing leased stores as they come up for renewal and (perhaps) swallowing the bitter pill a little faster on owned stores.

[peter1234]

An old story about closing Dempster Mill from Lowenstein's 'Making of an American Capitalist' might still be relevant:

 

To some extent, we have converted the assets from the manufacturing business which has been a poor business, to a business which we think is a good business—securities. The redeployment carried a cost. One hundred people were laid off, and Buffett met with heavy criticism in Beatrice.

 

Bill Otis, a bridge partner, asked him in a kidding vein, “How can you sleep at night after firing all those people?”

To Buffett, who had a thin skin where his reputation was concerned, it was no joke.

“If we’d kept them the company would have gone bankrupt,” he said. “I’ve kept close tabs and most of

them are better off.”

 

Though this has the ring of rationalization, Buffett hated being called a liquidator and vowed that he

would “never” lay people off again.